How to Sell Rental Property in California Without Paying Capital Gains Tax
You’ve spent years building equity in a California rental property. Maybe it was a duplex in Sacramento you picked up in your 40s, or a small apartment building that’s appreciated well beyond what you ever expected. Now you’re thinking about selling, but the tax bill is giving you pause.
California has some of the highest combined capital gains tax rates in the country. Between federal capital gains tax, depreciation recapture, and California state income tax, many investors end up losing 30 to 40 cents of every dollar in gains to taxes. That’s a significant amount of wealth that doesn’t have to disappear…but only if you plan ahead.
There are legal, IRS-approved strategies that California real estate investors use to defer capital gains taxes when selling a rental property. Here’s what you need to know.
Why California Rental Property Sales Trigger Such Large Tax Bills
When you sell a rental property in California, you’re typically on the hook for three layers of tax:
Federal capital gains tax – Up to 20% on long-term gains for high-income earners
Depreciation recapture – Taxed at 25% on all depreciation you’ve taken over the years
California state income tax – California taxes capital gains as ordinary income, with rates up to 13.3%
Together, this can mean an effective tax rate of 35% or more on your gains. For a Sacramento investor selling a property with $500,000 in capital gains, that’s potentially $175,000 or more walking out the door before you can reinvest a single dollar.
Strategy 1: The 1031 Exchange
The most widely used tax-deferral strategy for California real estate investors is the 1031 Exchange, named after Section 1031 of the Internal Revenue Code. It allows you to sell one investment property and reinvest the proceeds into another like-kind property—completely deferring your capital gains taxes in the process.
There’s no limit to how many times you can execute a 1031 exchange. Many investors use them repeatedly over decades to grow their portfolio without ever triggering a major tax event. And if you hold property until death, your heirs receive a step-up in basis—potentially eliminating the deferred gain entirely.
To qualify, you must:
Use a Qualified Intermediary (QI) to hold your sale proceeds—you cannot touch the money
Identify your replacement property within 45 days of closing on your sale
Close on the replacement property within 180 days
Purchase replacement property of equal or greater value than what you sold
Reinvest all net equity and replace any debt paid off
Legacy recommends starting your replacement property search before your relinquished property even hits the market. Forty-five days goes fast in a competitive California market.
→ To learn more about the requirements, read our article, 5 Rules to Know if You’re in or Considering a 1031 Exchange
Strategy 2: The Passive 1031 Exchange
One of the biggest challenges with a traditional 1031 exchange is finding a replacement property in time. That’s where a Delaware Statutory Trust, or DST, becomes a powerful solution for California investors.
A DST lets you invest in a fractional interest in institutional-grade real estate—think large multifamily communities, medical office buildings, or industrial facilities managed by professional sponsors. Because investors in a DST own a direct interest in real property, DST investments qualify as like-kind replacement property under IRS Rev Ruling 2004-86.
For Sacramento investors who are tired of landlord responsibilities or simply can’t find a suitable single property in time, a DST offers a way to complete the exchange on schedule, diversify across multiple asset types, and step into a fully passive ownership structure.
What Happens If You Just Sell and Pay the Taxes?
Some investors choose to sell outright and pay the capital gains bill. While there’s nothing wrong with that choice, it’s still worth running the numbers first. Every dollar paid in taxes is a dollar that can’t compound in your next investment. Over 10 or 20 years, the difference between deferring taxes and paying them today can be substantial.
A 1031 Exchange may not be the right strategy for every investor, but the key is making that decision deliberately instead of by default.
Talk to the Right Team Before You List
At Legacy Investments & Real Estate, we work with investors who are weighing a sale and want to understand all of their options before the clock starts. We’ll help you evaluate replacement property strategies and build a plan that fits both your financial goals and your life.
Give our team a call before you list—there’s no pressure, and the conversation is free.
Legacy Investments & Real Estate is your partner in passive real estate.
We are passionate in our pursuit to help every investor build their financial legacy by unlocking the power of passive real estate. Through custom strategies aligned to their unique goals and needs, we provide investors with the potential for all the benefits of real estate investing without the headaches of property management.
Ready for professional, tailored guidance on your passive real estate investment needs?
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There are material risks associated with investing in private placements, Delaware Statutory Trusts (“DSTs”) and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Legacy Investments & Real Estate is independent of CIS and CAM.